REASONS
FOR JUDGMENT
Lamarre A.C.J.
Introduction
[1]
This is an appeal from the assessments under
section 160 of the Income Tax Act (Act).
[2]
The appellant 3775305 Canada inc., formerly Enduits
LCR inc.\LCR Coatings Inc. (LCR), was the subject of an assessment for $136,739.39
on the ground that the company Revêtements Antoni Coatings inc. (Antoni,
now M.C.D. Wood Finishings inc.), with which it had a non-arm’s length
relationship, apparently transferred $185,837.14 to it, without giving consideration
equivalent to that transfer.
[3]
According to the Minister of National Revenue (Minister),
Antoni paid $478,845.99 to LCR in the following manner. Antoni paid $300,000 by
promissory note in addition to assuming the liabilities of LCR worth $178,845.99,
while the value of the assets that it apparently acquired from LCR was only $293,008.85.
However, on June 30, 2002, at the time of the transfer, Antoni had a tax debt
of $136,739.39.
[4]
The appellant René Lupien is the
shareholder and sole director of LCR. He has a non-arm’s length relationship with
LCR. He was the subject of an assessment for $136,773.10 on the ground that he
apparently received, in 2003 and in 2004, dividends from LCR exceeding $185,837.14.
However, according to the Minister, LCR still had, at the time when the
dividends were paid, a tax debt of $136,739.39, with the result that René Lupien
is jointly and severally, or solidarily, liable with LCR for that unpaid tax. The
difference between the amount of the assessment, that is, $136,773.10, and LCR’s
tax debt of $136,739.39 is unexplained. It was likely an error made in the
course of the assessment and must be corrected.
[5]
The appellants submit that they cannot be held jointly
and severally liable under paragraph 160(1)(e) of the Act because the
Minister should have allocated a value of at least $185,837.14 to LCR’s goodwill
at the time of the transfer of its assets to Antoni. The Minister submits that LCR
had no goodwill. The appellants do not dispute any other conditions for the
application of section 160.
[6]
If LCR is correct, it had no tax debt when the
dividends were paid to René Lupien and the two appeals will have to be
allowed. If there was goodwill, but the value of the goodwill was less than $185,837.14,
the appeals will have to be allowed in part to the extent that the goodwill
exceeded $49,097.75, that is, the difference between $185,837.14 and $136,739.39.
If there was no goodwill, or if there was goodwill but the value of the
goodwill was less than $49,097.75, the appeals will have to be dismissed.
[7]
There are two issues. First, did the appellant 3775305
Canada inc., formerly LCR, have goodwill on June 30, 2002? Second, if there was
goodwill, what was its value?
[8]
The following individuals testified: Normand Guindon,
the former president of Chemcraft International inc., including during the
relevant period in this dispute; Claude Lupien, the owner of Antoni and
the brother of René Lupien; Bernard Côté, a chartered accountant who,
during the relevant period in this dispute, was given the mandate to audit Antoni
and LCR; Denys Goulet, a member of the Canadian Institute of Chartered
Business Valuators, a witness for the appellant; and Lucie Demers, also a member
of the Canadian Institute of Chartered Business Valuators, an employee of the
Canada Revenue Agency (CRA). Denys Goulet and Lucie Demers testified
as expert witnesses. Bernard Côté testified as a fact witness.
[9]
The appellant René Lupien did not testify.
[10]
Many documents were filed in the record upon
consent.
[11]
The appeals were heard on July 15 and 16, 2013,
and on December 3, 2013, by Justice Jorré. The parties accepted by letter dated
July 14, 2015, that the determination of the appeals would be rendered by
another judge of the Court on the basis of the transcripts and exhibits in the
Court records.
The facts
[12]
In 1990, Antoni was created by Claude Lupien, who
indirectly holds 100% of the shares of Antoni, a company that manufactures
lacquers and develops varnishes and stains.
[13]
In 1993, René Lupien started working as Antoni’s
controller and he was also its director.
[14]
Before creating Antoni, Claude Lupien was
the shareholder of a company in the Chemcraft group. Chemcraft worked in the
same field as Antoni.
[15]
An Italian company, Milesi Spa (Milesi), wanted
to enter the Canadian and American markets.
[16]
On May 15, 2000, an exclusive distribution
agreement was signed between Antoni and Milesi. Antoni would import Milesi products
and distribute them in Canada and in 23 states in the United States. A
copy of that agreement is at Exhibit I‑1, Tab 7.
[17]
The terms of the agreement are not entirely
clear as to its duration (section 4 on the second page). For example, the
following sentence is difficult to understand: “[t]he
present agreement will be renewed previous consent of the parts”.
[18]
It is also clear that there was an initial period
of one year, that Milesi could end the agreement by simply providing notice
after one year if Antoni was not selling the minimum quantities of products set
out for the first year and that either party could end the contract at the end
of the first year by providing three months’ notice.
[19]
For the rest, even though there is some
ambiguity, it is clear from the other provisions in the agreement that before
the end of January every year the parties had to agree on the target quantities
of the products to be sold over the upcoming year, that one essential condition
of the validity of the agreement was that Antoni had to reach the targets and
that, if the targets were not reached, Milesi could end the contract by providing
some notice.
[20]
In summary, it seems that, in essence, there was
an intention to renew the agreement each year. However, if the targets were not
reached, Milesi could end the agreement. If the parties could not agree on the
targets, the contract would end.
[21]
In June 2000, René Lupien created LCR, and
was its shareholder and sole director. He remained employed by and continued to
be a director of Antoni.
[22]
LCR and Antoni’s fiscal years ended on January 31.
[23]
Antoni mandated LCR to distribute Milesi
products in Canada and in the United States. Antoni continued to manufacture,
sell and distribute its own products.
[24]
There was no written contract between Antoni and
LCR regarding the distribution of Milesi products. Claude Lupien’s testimony
on that issue was vague and did not clarify, assuming that there was a
contract, its terms. Inter alia, his testimony did not clarify whether
it was determinate or determinable in duration or whether Antoni could end it
at any time.
[25]
The Minister assumed that LCR was operating its
company on Antoni’s premises and that it used Antoni’s facilities, staff, equipment
and accounting software. However, according to the evidence, René Lupien was
both an employee of LCR (the only employee) and of Antoni. Tab 11 of
Exhibit I‑1 shows the salaries René Lupien received from Antoni and LCR
in 2000, 2001 and 2002.
[26]
Antoni ordered products from Milesi, imported
them, stored them on its premises and handled them. LCR distributed the
products and was also in charge of after-sales services. It was only when LCR sold
products that it purchased the corresponding quantity of products from Antoni.
Antoni received a certain percentage as remuneration for its services. The Milesi
products were therefore still owned by Antoni until LCR bought the products, at
which point LCR became responsible for insuring them.
[27]
At times, in his testimony, Claude Lupien seemed
to suggest that LCR took over the distribution contract between Antoni and
Milesi and that before the sale to Chemcraft International inc. (Chemcraft),
which I will discuss later, Antoni took back the contract. Factually, it is clear
from the evidence that such was not the case. Antoni had always ordered
products from Milesi to sell them to LCR.
[28]
Antoni and LCR had representatives and distributors.
They could sell products distributed by Antoni or LCR, but the Milesi products
had to be ordered from LCR and, save some exceptions, non-Milesi products had
to be ordered from Antoni.
[29]
In 2001, Normand Guindon, the president of
Chemcraft, and Claude Lupien met at a trade show in the United States. Normand Guindon
told Claude Lupien that Chemcraft wanted to buy Antoni. For Chemcraft, an
essential element of the proposed transaction was the distribution of Milesi
products.
[30]
Subsequently, on November 15, 2001, Chemcraft sent
a letter of intent reflecting its interest. That letter did not mention LCR because
at that stage Chemcraft did not know that LCR existed. The suggested purchase
price for Antoni’s shares was approximately $2.2 million and the value
assigned to the goodwill was $1.2 million. There were also non-competition
agreements to be signed by Antoni’s directors and officers. Everything was subject
to an audit. Chemcraft reserved the right to purchase assets instead of shares.
[31]
After a careful audit, Chemcraft found out about
LCR and wanted to acquire LCR and Antoni. Chemcraft wanted to acquire
everything. A factor that pushed Chemcraft to want to acquire everything was
the past legal dispute between it and Claude Lupien after the latter left Chemcraft.
That legal dispute was settled out of court.
[32]
A memorandum of understanding between LCR,
Antoni and Chemcraft was signed on April 29, 2002. It provided that Chemcraft would
purchase the assets of LCR and Antoni. The price was $2.2 million. It also
provided that Claude Lupien would be employed by Chemcraft for a period of
one year after the acquisition of Antoni and that Claude and René Lupien would
have to sign non‑competition agreements.
[33]
Antoni bought LCR’s assets through a contract signed
on June 30, 2002.
The purchase price for the assets was $332,632.80. The price was to be paid in
the following manner: Antoni had to assume the liabilities of $21,433.36 indicated
in Annex B of the contract and also had to issue a promissory note for $311,199.44
to LCR. The contract itemized the goods purchased and their value in Annex A.
Annex B itemized each liability and its value.
[34]
No goodwill was included in the acquired goods
itemized in Annex A. However, subsection 5.2 of the contract stipulates that
LCR will change its name and will not use, in its name, or in the course of its
operations, the words “REVÊTEMENTS ANTONI COATINGS
INC.” or “ENDUITS LCR INC./LCR COATINGS INC.” It also stipulated that LCR will not use similar words. The
contract also contained a price adjustment clause.
[35]
After the signing of the contract on June 30,
2002, it was purportedly discovered that the liability amount declared in the
contact had been understated by $157,412.63.
[36]
Indeed, Antoni had paid the LCR a total of $478,845.99
instead of the $332,632.80 stipulated in the contract. That amount was paid in
the following manner: Antoni assumed LCR’s liabilities for a total value of $178,845.99
and issued LCR a promissory note for $300,000 (not for the $311,199.44 set out
in the contract).
[37]
No new contract amended the contract dated June
30, 2002.
[38]
In his testimony, Claude Lupien did not
describe negotiations or discussions with his brother regarding the contract
dated June 30, 2002, and did not explain how the brothers decided on the price
of $332,632.80 stipulated in the contract. He also did not describe negotiations
or discussions after June 30, 2002, with his brother regarding the increase in
price, which went from $332,632.80 to the payment of $478,845.99. In
cross-examination, he recognized that the two brothers discussed about an
approximate figure of $300,000, subject to confirmation by the financial
statements.
[39]
However, Claude Lupien explained why he was
of the view that a price of $478,845.99 was warranted. According to him, that
price of $478,845.99 was warranted because it was close to a quarter of the
price paid by Chemcraft, and LCR represented about 25% to 30% of the sales of Antoni
and LCR combined.
However, it must be noted that as to gross sales, the financial statements for Antoni’s
2002 fiscal year indicate sales of $3,584,650 whereas, as to gross sales, the
financial statements for LCR’s 2002 fiscal year indicate sales of $698,411, that
is, a total of $4,283,061 for the two companies. LCR’s sales represented about
16% of the total.
[40]
A few days before July 31, 2002, Normand Guindon
went to Italy to personally meet the president of Milesi to ensure that Chemcraft
would keep the exclusive right to distribute Milesi products in Canada and in
the United States after purchasing Antoni. Mr. Milesi orally agreed that it
would keep the distribution if the sales targets were reached; Normand Guindon
and Mr. Milesi shook hands.
[41]
On July 31, 2002, Chemcraft bought Antoni’s assets,
including Antoni’s product formulas, considering that Antoni had previously
bought LCR’s assets. The total purchase price was $2,697,248 ($2.2 million
for the purchase of the assets and the rest for the assumption of liabilities) and
$755,993 was attributed to goodwill.
[42]
On July 31, 2002, René Lupien signed a
non-competition agreement with Chemcraft. He did not receive any payment in exchange
for that agreement. The agreement states that Chemcraft bought Antoni’s assets and
that part of the purchase price that Chemcraft paid to Antoni would allow
Antoni to pay the promissory note to LCR.
Goodwill
[43]
The Minister assumed, at paragraph 17(p) of the Reply
to the Notice of Appeal in the two cases, that LCR received $185,837.14 more
than the fair market value of the assets LCR had sold to Antoni.
[44]
That calls for two comments. First, on June 30,
2002, Antoni and LCR signed a contract for Antoni’s purchase of LCR’s goods for
a price of $332,632. After the discovery that LCR had additional debts, Antoni paid
a total of $478,845.99, an increase of about 44% with respect to the agreed
price of $332,632, despite the fact that there was no other written contract
that identified the purchase of an additional asset. Furthermore, the evidence
did not show any negotiations between Claude and René Lupien on the
increase in the amount paid by Antoni. That does not reflect the conduct typical
of persons dealing with each other at arm’s length.
[45]
Second, according to the appellants, the additional
amount paid in excess of the agreed price ($332,632) in the contract dated June
30, 2002, was offset by the goodwill valued at between $150,000 and $200,000, according
to Mr. Goulet’s expert report. Given the importance now sought to be attributed
to the goodwill, it is surprising to say the least that the list of assets in
Annex A of the contract does not mention that goodwill.
[46]
What is this goodwill? That is not clear. It
could not have been René Lupien’s personal goodwill, as LCR could not sell that. Was it a contract? It could
not be the contract with Milesi, as the evidence is clear Antoni is the one that
had a contractual relationship with Milesi.
[47]
Was it a contract between Antoni and LCR that stipulated
that LCR would distribute Milesi products for Antoni? There is certainly a lack
of evidence on this. If there was such contract, its value is impossible to determine
without knowing its provisions. In particular, it would be fundamental to know
the terms with respect to its duration. Was there a fixed term? Could the
contract be terminated without notice, or was notice necessary? If so, what was
the notice period? A company would not pay to end a contract if it could simply
give the required notice under the contract.
[48]
Claude Lupien’s testimony and the documents
do not contribute any information on any terms of such contract between Antoni
and LCR for the distribution of Milesi products, assuming that such contract
existed. René Lupien did not testify. The contract dated June 30, 2002,
does not mention any such contract. Logically, the inference is that there was
no need to mention it. Indeed, either there was no contract, or there was a
contract that could be terminated without notice, or there was a contract and
the necessary notice was given.
[49]
According to the contract of sale dated July 31,
2002, between Chemcraft and Antoni, LCR had 18 clients or distributors. In
comparing the lists of Antoni and LCR clients, it can be seen that 14 of LCR’s
clients were also Antoni’s clients, including the two distributors Contemporary
Furniture and Ferreira Pitts. Those two distributors were bound by a
distribution contract with Antoni and those two contracts were part of what Antoni
sold to Chemcraft. The contract of sale dated July 31, 2002, does not
mention a distribution contract between LCR and Contemporary Furniture or between
LCR and Ferreira Pitts.
[50]
In its first year, all of LCR’s clients were
also Antoni’s clients.
[51]
Claude Lupien testified that Antoni was
paid for the services provided to LCR in the form of a percentage of LCR’s
sales. LCR’s financial statements indicate storage costs of $0, $69,095 and $14,440
paid by LCR to a non-arm’s length company, Antoni, during the 2001, 2002 and
2003 fiscal years, respectively. The financial statements do not indicate any
other expenses paid to Antoni. Those amounts are highly variable and are not a
fixed percentage of LCR’s sales.
[52]
Bernard Côté is a chartered accountant and he was
given the mandate to audit Antoni and LCR. He testified as a fact witness. He
explained that he had assumed that the surplus of $185,837.14 paid to LCR in
excess of the amount of $293,009 for the goods listed in Annex A of the contract
was goodwill. At one point after July 31, 2002, after the two transactions,
he did the calculation mentioned in Exhibit A‑4. That calculation
compares the relative profits of Antoni and LCR. Based on his calculation, he believed
that an allocation to LCR of 25% in the amount of $775,993 paid by Chemcraft to
Antoni for goodwill was reasonable.
[53]
Mr. Côté’s calculation merged the results
for the 2002 fiscal year and the first five months of the following year, that
is, the last five months of LCR’s operations. For those 17 months combined,
LCR received about 26% of LCR and Antoni’s combined profits. However, looking
at the 2002 fiscal year and at the first five months of the following year
separately, it is apparent that during the 2002 fiscal year, LCR received about
40% of the combined profits, whereas for the first five months of the following
year, LCR received only 12% of the combined profits.
Denys Goulet’s expert
report
[54]
Mr. Goulet’s mandate was as follows:
[translation]
The goal of this report is to estimate the fair market value of the portion
of goodwill paid by Chemcraft [$755,993], at the closing of the Transaction [between
Chemcraft and Antoni], which was attributable to LCR’s activities at July 31, 2002
. . . .
Because some
documents were missing and a lot of time had passed since the transaction, he
did what is called an estimate of value report.
[55]
Mr. Goulet determined that the transactions
on June 30, 2002, and July 31, 2002, needed to be assessed as a whole
and that the transaction on June 30, 2002, could not be assessed in
isolation.
[56]
Mr. Goulet is of the view, but did not consider
this in his valuation, that Chemcraft was a special purchaser, that is, a purchaser
that, for its own reasons, such as the possibility of achieving economies of
scale, synergies or strategic advantages in the long term, would be likely to
pay a premium to acquire a company. According to Mr. Goulet, he did not explicitly
consider this, but it was a consideration that he had to keep in mind when it
came to establishing the value,
[57]
Mr. Goulet stated that, in
the context of a business valuation, there must be consideration of the [translation] “nuisance value”, that is, a shareholder’s ability to block a transaction,
and because, according to him, René Lupien had such ability, he considered that
element in his analysis.
[58]
Mr. Goulet assumed, among other things,
that
[translation]
1. all of the remuneration paid to the officers
of Antoni and L.C.R. and to members of their family, corresponded to that which
a potential buyer of all of the outstanding shares of Antoni and L.C.R. would
have had to assume globally;
2. the
transactions between the non-arm’s length parties, in particular the transactions
between Antoni and L.C.R., were done on the same terms as those of the arm’s
length parties;
3. there
was an oral agreement between Antoni and L.C.R. according to which L.C.R. exclusively
distributed Milesi products on behalf of Antoni; and
4. potential
buyers of Antoni’s shares or assets would continue to honour the Milesi product
distribution agreement reached orally between Antoni and L.C.R. on the same
terms as those that prevailed in the 2002 fiscal year and for a reasonable
period of time.
[59]
There are four significant points that arise
from Mr. Goulet’s analysis: the fact that if Chemcraft did not acquire LCR, the
transaction would fail; the fact that even if, contractually, the transaction was
made through two separate documents, from a business perspective, there would
only be one transaction; the fact that René Lupien did not receive any remuneration
for his undertaking to not compete with Chemcraft; and the fact that the distribution
of Milesi products was an activity that could very quickly be integrated into
Chemcraft.
[60]
Mr. Goulet opted to assess the portion of
the purchase price attributable to LCR’s goodwill using two market-based
approaches: first, an analysis using the parameters of the transaction between
Chemcraft and Antoni and, second, an analysis based on transactions of
comparable public companies. He also used the performance-based approach and,
more specifically, the method of capitalizing the representative net cash flow
before carrying charges.
[61]
The first market-based approach consisted in comparing
the sales of Antoni and LCR together and the sales of Antoni alone, both for
the 2001 fiscal year and for 2002. He found that profitability would have been
different if LCR had not been included in Antoni and Chemcraft’s transaction. Mr. Goulet
therefore estimated, on that basis, that the value of LCR’s goodwill was approximately
between $175,000 and $245,000.
[62]
The second market-based approach consisted in
comparing the transaction between Antoni, LCR and Chemcraft with other similar transactions
involving public companies active essentially in the same field. Mr. Goulet
found that by buying both LCR and Antoni, Chemcraft paid about 34% less than if
it had bought a public company directly, and he noted that that was normal
because public companies are more substantial (in sales and size) than private
companies. He therefore applied that reduction factor to the sales and
determined that the fair market value of LCR’s goodwill on the valuation date was
between $120,000 and $190,000.
[63]
The last approach used by Mr. Goulet was to
assess LCR’s value on the basis of its own financial performance and he
considered not only its past profits, but also its future profits. Using that valuation
method, he found that the fair market value of LCR’s goodwill on the valuation
date was between $160,000 $ and $230,000.
[64]
In the light of all of the results derived from
the various methods applied, the fact that, according to him, René Lupien could
have, at any time, terminated the transaction between Antoni and Chemcraft and
the fact that he signed a non‑competition agreement without provision for
remuneration,
Mr. Goulet found that the fair market value of LCR’s goodwill on the valuation
date was in the range of $150,000 to $200,000.
Lucie Demers’ expert
report
[65]
As to Ms. Demers, she provided another type of valuation
report, a comprehensive valuation report, and determined the fair market value
of LCR’s goodwill as of June 30, 2002.
[66]
Ms. Demers considered that there had been two transactions
between the parties, an initial transaction between LCR and Antoni and a second
transaction between Antoni and Chemcraft. She therefore took into account, in
her valuation, only the facts pertaining to Antoni’s acquisition of LCR.
[67]
Ms. Demers assumed that there was no
exclusive product distribution contract between Antoni and LCR and that in the
event of a misunderstanding between the two brothers, the continuation of LCR’s
activities would be compromised. She accepted that hypothesis because, in an
interview with René Lupien, he had told her that he was never told about
the contract between Milesi and Antoni and that Antoni had not told him that
there were product purchasing targets that had to be achieved in order for the
contract to remain valid. Thus, if Antoni had given LCR the exclusive right to distribute
Milesi products as claimed, Antoni would have, logically, provided LCR with the
contract details.
[68]
Ms. Demers does not believe that the transactions
between Antoni and LCR took place under the same conditions as those between
parties dealing with each other at arm’s length. She gave the example that LCR had
no line of credit because Antoni was financing it by not requesting inventory
payments.
[69]
Ms. Demers believes that the only reason Chemcraft
wanted to acquire LCR at the same time as it acquired Antoni was that it did
not want a repeat of the litigation that had occurred with Claude Lupien.
[70]
Ms. Demers is not of the opinion that Chemcraft
or Antoni was a special purchaser. To use that phrase, there would have needed
to be, for example, another buyer that had wanted to acquire LCR and that other
buyer would have had to be systematically acquiring distributors at that time. Furthermore,
she stated that Chemcraft was indifferent to the structure of the sale, because
it stated in the letter of intent and in the memorandum of understanding that
it could buy the assets or the shares, whichever was most beneficial from a tax
perspective.
[71]
In her evaluation, Ms. Demers did not
consider the presence of a “nuisance value” because Chemcraft did not
necessarily need to acquire LCR to have the right to exclusively distribute Milesi
products.
[72]
Ms. Demers did not give weight to the
non-competition agreement signed by René Lupien in determining the fair
market value of LCR’s goodwill because, in the letter of intent of November 2001,
Chemcraft already stated that in exchange for the purchase price it wanted Antoni
and Antoni’s subsidiaries, officers and directors to sign a non-competition
agreement, and René Lupien was one of Antoni’s directors at the time.
[73]
Ms. Demers used, for her analysis, the profit-based
approach and, specifically, the capitalization of cash flow method.
[74]
In examining the financial statements, she
discovered that on June 30, 2002, LCR had made slightly lower sales than it had
on the same date the year before. She therefore does not agree with the theory
that LCR’s sales were growing and that LCR’s possible future profits needed to
be considered in determining the value of the goodwill, particularly given that
LCR was fragile as an entity because 82% of its sales came from only two
clients and those clients were also clients of Antoni, or even because there was no stability
in its expenditures (for example, the rental expenses in 2001 were $0 and, in
2002 they were $70,000). She also pointed out that LCR’s profits were
overvalued because it was not covering certain expenses that it was supposed to
be covering, as Antoni was helping it. For all of these reasons, she concluded
that LCR had no goodwill on June 30, 2002, and that LCR’s only assets that
could have been sold were cash, inventory and client accounts.
Analysis
[75]
The Federal Court of Appeal discussed the nature
of goodwill in TransAlta Corporation v. Canada. At paragraphs 51 to 55, the
Court stated:
The concept of goodwill
[51] The Tax Court judge relied on the
following definition of goodwill set out by Lord Macnaghten in Muller at
pp. 223-224:
What is goodwill? It is a thing very
easy to describe, very difficult to define. It is the benefit and advantage of
the good name, reputation, and connection of a business. It is the attractive
force which brings in custom. It is the one thing which distinguishes an
old-established business from a new business at its first start. The goodwill
of a business must emanate from a particular centre or source. However widely
extended or diffused its influence may be, goodwill is worth nothing unless it
has power of attraction sufficient to bring customers home to the source from
which it emanates. Goodwill is composed of a variety of elements. It differs in
its composition in different trades and in different businesses in the same
trade. One element may preponderate here and another element there. To analyze
goodwill and split it up into its component parts, to pare it down as the
Commissioners desire to do until nothing is left but a dry residuum ingrained
in the actual place where the business is carried on while everything else is
in the air, seems to me to be as useful for practical purposes as it would be
to resolve the human body into the various substances of which it is said to be
composed. The goodwill of a business is one whole, and in a case like this it
must be dealt with as such.
[52] This definition was developed well over
a century ago at a time when a client base and good reputation were understood
as the principal elements of goodwill. Although this definition is still
useful, important developments in the fields of business, accounting, valuation
and law in the last century also need to be taken into account in order to
better understand the modern concept of goodwill.
[53] As noted by Lord Macnaghten, goodwill
is a concept which is difficult to define. It is composed of a variety of
elements, and its composition varies according to different trades and
different businesses in the same trade. Consequently, even after much study and
numerous publications on the subject, a proper definition of goodwill has
eluded both the legal and the accounting professions. Like the accounting
profession, I conclude from this that any attempt to define goodwill is doomed
to failure. Rather, various characteristics inherent to the notion of goodwill
should be identified and then used to ascertain goodwill on a case-by-case
basis.
[54] As noted at the outset of these
reasons, three characteristics must be present in order for goodwill to be
found: (a) goodwill must be an unidentified intangible as opposed to a tangible
asset or an identified intangible such as a brand name, a patent or a
franchise; (b) it must arise from the expectation of future earnings, returns
or other benefits in excess of what would be expected in a comparable business;
(c) it must be inseparable from the business to which it belongs and cannot
normally be sold apart from the sale of the business as a going concern. If
these three characteristics are present, it can be reasonably assumed that
goodwill has been found: see John W. Durnford, “Goodwill in the Law of Income
Tax” (1981), 29(6) Canadian Tax Journal 759 (“Durnford”), at pp. 763 to 775;
see also Muller above; Manitoba Fisheries Ltd. v. Canada, [1979]
1 S.C.R. 101; Dominion Dairies Limited v. Minister of National Revenue
(1965), 66 D.T.C. 5028 (Ex. Ct.); Les Placements A & N Robitaille Inc.
v. The Minister of National Revenue (1994), 96 D.T.C. 1062 (T.C.C.); FCT
v. Murray (1998), 155 ALR 67 (Aus. H.C.).
[55] An
established reputation, customer satisfaction, a unique product or process
leading to a monopolistic position, good or astute management, favourable location,
manufacturing efficiency, harmonious labour relations, advertising, quality of
products, and financial standing have all been found to constitute goodwill
insofar as they meet the three characteristics: Durnford at pp. 772-773.
[76]
It is apparent from what I just cited that
goodwill is a whole that can consist of various elements. The existence of
elements that would bring additional value to other acquired assets must be shown.
[77]
In this case, the goodwill must be valued at at
least $49,097.75 before the assessments at issue can be reduced.
[78]
There is no doubt that Chemcraft wanted to
acquire everything.
[79]
According to the appellants, regard must be had
to (i) the fact that there was, in reality, from an economic perspective, a
single transaction, the transaction whereby Chemcraft bought Antoni and LCR, (ii) the
leverage for Chemcraft, which resulted from combining the distribution of all
of the products purchased with the distribution of its own products, (iii) the
existence of an exclusive contract for the distribution of Milesi products in
Canada and in the United States between LCR and Antoni, (iv) the reputation
of the Milesi products, (v) LCR’s “nuisance value” and (vi) the
fact that goodwill is a whole, as held by the case law.
[80]
While it is true that Chemcraft wanted to buy
everything and that the transaction on July 31, 2002, was part of the context,
Antoni and LCR were separate legal entities and the transaction on June 30,
2002, between those two companies was separate from the one on July 31, 2002,
between Chemcraft and Antoni. It is necessary to examine the sale between
Antoni and LCR separately.
[81]
Factually, even assuming that there was a Milesi
product distribution contract between Antoni and LCR, we do not have evidence on
the terms of that contract. Claude Lupien could have testified on that
point. He did not. René Lupien did not testify at all.
[82]
The respondent asked the Court to draw a negative
inference from the fact that René Lupien did not testify. In this case,
regarding the terms of the contract that may have existed between Antoni and LCR,
there should be a negative inference from René Lupien’s absence of
testimony.
[83]
With respect to the possible need to prematurely
terminate the distribution contract between LCR and Antoni, that would have needed
to have been addressed in the contract dated June 30, 2002, and have been attached
a value. The contract between Antoni and LCR did not impede the transaction with
Chemcraft because it could be terminated without notice and because the notice
period was very short and did not pose any problem. The consequence is that that
contract also had no “nuisance value”.
[84]
More generally, on a practical level, LCR did
not have a significant “nuisance” power for the following reason: Antoni could adversely
affect LCR more than LCR could adversely affect Antoni because LCR was almost
completely dependent on Antoni. If Antoni had ended the distribution contract
with LCR, LCR would have had nothing left to distribute.
[85]
The reputation of the Milesi products certainly
has a value, but the Milesi brand did not belong to LCR and could not create
goodwill that belonged to LCR. The distribution contract was between Antoni and
Milesi and not between Milesi and LCR. That contract also could not create
goodwill belonging to LCR.
[86]
The leverage raised by the appellants involves benefits
from the common distribution of not only Milesi products, but also Antoni
products, with products that Chemcraft already had. For Chemcraft, those
benefits have a financial value. The logic of such argument is that the seller,
being aware of the value of those benefits, may succeed in negotiating that it
be paid a portion of that value. For LCR to negotiate a portion of that value,
LCR would have had to have been able to block the transfer of the distribution of
Milesi products to Chemcraft. For the above-mentioned reasons, LCR was not able
to jeopardize the transfer. Antoni had the exclusive distribution contract with
Milesi.
[87]
The list of LCR clients was mentioned, but that
list could not have substantial value given that the clients were almost all
clients of Antoni, including the two LCR distributors, which were also
distributors of Antoni.
[88]
The appellants submitted that René Lupien signed
the non-competition agreement without receiving direct remuneration, that that
agreement alluded to the fact that René Lupien indirectly profited from Chemcraft’s
purchase of Antoni’s assets because part of the price paid by Chemcraft allowed
Antoni to pay the price to LCR for the purchase of its goods and that the memorandum
of understanding dated April 29, 2002, provided for that non‑competition
agreement.
[89]
All of that is correct, but that is no use to
the appellants. Assuming that there was a substantial value to René Lupien’s
commitment to not compete with Chemcraft, LCR had no right that would have
allowed it to sell René Lupien’s personal commitment to any party.
[90]
I agree with the appellants that goodwill is a
residual category of goods that can include several elements of a considerably
varied nature. However, there must still be elements of goodwill.
[91]
Factually, I am not convinced of the presence of
elements of goodwill, with one exception, which I will address shortly.
[92]
There is also another ground that leads to the
same finding. The contract dated June 30, 2002, is very specific. Antoni bought
the goods listed in Annex A. There is no mention in Annex A of goodwill or
elements that can constitute goodwill.
[93]
The appellants did not submit that there was a
change to the contract, or a second contract, to purchase something else, and
there is no evidence that there was a change to the contract or a second
contract. Assuming, hypothetically, that there was substantial goodwill, LCR could
not have sold Antoni that which was not set out in the contract dated June 30,
2002. It is worth bearing in mind that Antoni bought the assets, not the
company LCR.
[94]
As stated above, there is only one exception. Clause 5.2(c)
of the contract dated June 30, 2002, states that LCR commits to changing its
name and to no longer using that name. A name can constitute goodwill, but
Antoni and LCR did not give it value in the contract dated June 30, 2002. They
did not even mention the name in Annex A.
[95]
Clause 2.1(n) of the contract dated July 31,
2002, between Chemcraft and Antoni gives, inter alia, Chemcraft the
exclusive right to use the name LCR.
[96]
What is the value of the name LCR? The factual
evidence does not indicate that the name LCR could have significant value. The
factual evidence is that the Milesi products were important for Chemcraft and,
also, the Antoni products, including Antoni’s formulas. When Chemcraft sent its
letter of intent in November 2001, it did not know that LCR existed. The
evidence does not support the finding that the name LCR had substantial value.
[97]
In summary, the factual evidence does not show
that there are elements of goodwill, let alone that there was at least $49,097.75
in goodwill value.
[98]
Although I am of the opinion that that is unnecessary,
before concluding, I will make a few comments on Mr. Goulet’s expert
report.
[99]
Among the factors that have a significant impact
on any expert report is the question put to the expert and whether the facts on
which the opinion is based are accurate.
[100] Mr. Goulet’s task was [translation]
“to estimate the fair market value of the portion of goodwill paid by Chemcraft Sadolin inc. on July 31, 2002, which was attributable
to [LCR’s] activities”.
Although there is a connection, that was not directly the issue to be
determined in this dispute. The issue here is: what is the value of the
goodwill sold by LCR to Antoni?
[101] For the purposes of his analysis, Mr. Goulet assumed, in
particular, that
[translation]
1. all of the remuneration paid to the officers
of Antoni and L.C.R. and to members of their family, corresponded to that which
a potential buyer of all of the outstanding shares of Antoni and L.C.R. would
have had to assume globally;
2. the
transactions between the non-arm’s length parties, in particular the
transactions between Antoni and L.C.R., were concluded on the same terms as
those of the arm’s length parties;
3. there
was an oral agreement between Antoni and L.C.R. according to which L.C.R.
exclusively distributed Milesi products on behalf of Antoni; and
4. potential
buyers of Antoni’s shares or assets would continue to honour the Milesi product
distribution agreement reached orally between Antoni and L.C.R. on the same
terms as those that prevailed in the 2002 fiscal year and for a reasonable
period of time.
[102] I believe that those assumptions are not realistic in the factual circumstances
of this dispute.
[103] As for the first assumption, regarding remuneration paid in
incorporated family businesses, there can be no assumption that remuneration
paid to owners who are also directors or employees, including the remuneration LCR
paid to René Lupien, is the same as that which the business would pay to
an arm’s length employee. For example, contrary to what happens when an arm’s
length individual is paid, sole owners who are employees can very well choose a
lower salary for various reasons, such as tax planning, because they can
subsequently be paid the resulting increase in profits in the form of dividends.
[104] Regarding the second assumption, Antoni and LCR were not operating under
the same conditions as would be the case if they were dealing with each other
at arm’s length. That can be seen in the conduct after the sale on June 30, 2002,
when, after discovering LCR’s additional debt, Antoni simply increased the
price paid.
[105] That can also be seen in the financial statements. Claude Lupien testified
that Antoni was paid in the form of a percentage for the services provided to LCR.
However, according to the financial statements, the fees paid by LCR to Antoni
seemed to vary significantly from year to year, and it seems that the
percentage varied from year to year with respect to sales. For the eight months
of the 2001 fiscal year, LCR, which had sales of $165,000, paid Antoni nothing
in storage fees, whereas, for the 2002 fiscal year, LCR, which had sales of $698,000,
paid Antoni $69,000 in storage fees. For the five months of operations in the 2003
fiscal year, LCR, which had sales of $290,000, paid Antoni $14,400 in storage
fees.
Between arm’s length companies in the 2001 fiscal year, one company would not
have rendered its services to the other company free of charge.
[106] Regarding the last two assumptions, as seen above, the contract
between LCR and Antoni could not have value because it could be terminated
quickly and it follows that there was no obligation to continue the contract.
[107] The financial statements do not faithfully represent LCR’s profits if
the transactions between Antoni and LCR and between René Lupien and LCR were
not done under the same conditions as transactions between third parties, in
particular regarding prices. Had it been necessary to consider the expert
reports, since Mr. Goulet’s estimates depended in large part on LCR’s
financial statements, in particular the profits stated therein, the consequence
would have been that his calculations could not have been accepted as stated.
Conclusion
[108] The evidence does not show goodwill elements that could have substantial
value. What that value might be, it would fall very short of the threshold of $49,097.75,
which is necessary before there can be a practical effect on the assessments.
As a result, the appeals are dismissed with respect to
their substance.
[109] However, as stated at the beginning of these reasons, René Lupien’s
assessment is a few dollars more than LCR’s tax debt for unknown reasons. The
appeal from René Lupien’s assessment will be allowed only to correct this.
Signed at Ottawa,
Canada, this 5th day of January 2016.
“Lucie Lamarre”
Translation certified true
on this 27th day of June 2017
François Brunet, Reviser
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